Last week Canada became the first G7 country to cut interest rates, moving its policy rate from 5.0% to 4.75%, having held the rate since July 2023. Canada’s 5-10 year government bond yields average c. 3.4% (Source: Bank of Canada) and so it’s a good moment to remind ourselves of Middlefield Canadian Income’s (MCT) significant active position in Canadian REITs, approximately a quarter of the trust’s portfolio and four times the weight in MCT’s benchmark. This is a long-standing position in part driven by MCT’s income mandate, but in the last year or two increasingly driven by the manager’s rising conviction that Canada’s listed property companies are significantly undervalued, even as many of them have seen rental growth. Canada’s real estate market has several supply constraints, as while Canada is by area a vast country, the overwhelming majority of the population live in and around a few urban centres where supply is constrained in areas such as housing and industrial warehouses, both of which have a ring of familiarity for investors in real estate closer to home in the UK. To put those Canadian REIT’s into context against interest rates and bond yields, the average yield, based on one of the leading ETFs that follows the REIT index, is c. 5%, with MCT’s own portfolio yielding perhaps 20-30 basis points less than this, as the team are focused on quality rather than yield for yield’s sake.
MCT is also exposed to other interest-rate sensitive sectors such as energy infrastructure, including Canada’s vast pipeline sector, which helps to make Canada the US’s leading external supplier of energy, as well as utilities. MCT’s managers noted that on the day of the announcement all of these sectors showed positive gains. Given that the central bank appeared to be suggesting this won’t be the last rate cut this year, it’s unsurprising the Canadian dollar weakened slightly, making the market slightly cheaper still for sterling-based investors.
The MCT team thinks this is the first step back to neutral interest rates, with inflation having responded to higher rates and moving towards its target rate. The bank made all the expected caveats to the effect of ‘one step at a time’ but the team expect a further cut in July this year and they would not be surprised to see the rate down to 4.0% by the first quarter of next year. With the relative appeal of cash and near-cash diminishing, the team feel this cut could mark the beginning of a flow into equities that should benefit the types of equity income stocks that MCT is firmly focused on. MCT’s shares trade on a c. 12% discount and the dividend yield is c. 4.9%, so the rate cut makes it’s own dividend yield higher than the bank rate.
